Matching supply and demand in the airline industry

How should airlines respond to seasonal swings in demand? The Wall Street Journal reports that they have gotten more aggressive in using operational response (Airlines Lose the Winter Blahs, Feb 29). That is, airlines are fine tuning their capacity as opposed to resorting to discounts to fill up planes.

First, it is worth noting that the difference between winter and summer demand levels results in some eye-popping numbers. The article reports that across the entire industry airlines 77% of their available seats in January of 2011. In July of that year, the comparable number is 87%. If that difference doesn’t grab your attention, the kicker is that the industry as a whole flew 17% more seats in July!

So what are they doing differently?

To better manage the seasonal miniboom and minibust cycle, they’re scheduling more aircraft for maintenance and cabin renovations during the slower winter months. They’re also offering workers voluntary leaves, flying their planes fewer hours a day and trimming the number of daily flights to many destinations. Trans-Atlantic schedules, which swell in the summer months, are throttled back the rest of the time.

These initiatives come as U.S. carriers are already working harder to match capacity to demand and have cut overall domestic seats and flights. Offering fewer seats makes it easier to raise fares at a time when oil prices are hitting highs. With fuel now accounting for more than a third of carriers’ operating expenses, “it becomes more and more important not to fly that airplane if there’s no demand,” says Alaska’s Mr. Harrison.

The airlines’ fine-tuning by season is aided by improved forecasting tools. “We are no longer using an ax to adjust the schedule,” says Andrew Nocella, senior vice president of marketing and planning at US Airways Group Inc. “We’re using a scalpel. We want to tilt the capacity toward better [demand] days.”

To put these changes in perspective, the article reports that Delta is now targeting having winter capacity being 20 to 25% lower than summer capacity.

Taking advantage of slack periods of demand to do maintenance or overhauls seems pretty obvious and it is hard to imagine that they weren’t doing this before. No amusement park is going to schedule work on its most popular ride for a holiday weekend so I have to think that airlines were only doing truly necessary work during the busy summer.

The interesting part here is the comment about fuel prices. That suggests that variable expenses are a bigger part of the picture than they were when fuel prices were lower. On top of that, airlines have used bankruptcy as a way to remake their total cost structure.

Cutting capacity effectively raises unit costs because the airlines’ large fixed expenses are distributed over fewer seats. The calculus is: “What assets do I have to carry throughout the year to justify serving a market for six months at the peak?” says Delta’s Mr. Hauenstein.

Ten years ago, airlines couldn’t shrink their way to profitability, says John Heimlich, an economist for the Airlines for America trade group of leading U.S. carriers. That’s less true now, he says, because airlines’ fixed costs have fallen to 50% to 60% of their total costs from up to 75% a decade ago. The shift occurred as airlines restructured in and out of bankruptcy court, achieved savings through mergers, and outsourced maintenance, catering and ground-handling jobs.

In addition, airlines are “moving to forgo some of the peak volume in order to…realize a more favorable mix of traffic,” Mr. Heimlich says.

So greater labor flexibility is a big part of the story. If ground jobs at many airports are outsourced and tapped on an “as-needed” basis, it is a lot easier to cut back flights. That all suggests that prices should stay high. Scaling capacity up and down should make it possible to keep planes full without having resorting to deep discounts.